In the Market for Pollution: Carbon Trade or Carbon Con?

In the carbon market, a good deal for the environment needs to also be a good deal for the bottom line. Vouching for the environmental credibility isn't easy: Who verifies the verifiers? The third in a three-part series

NEW YORK—A company recycles a product, doing its part for the environment through reuse, only to be told it's worth more to destroy it. Welcome to the wonderful world of the carbon market, especially for a company that deals in refrigerants.

These gases, culprits in no less than two environmental crimes—the ozone hole and climate change—are required to efficiently cool your food and beverages. Yet, chlorofluorocarbons, to give them their proper name, are potent molecules that both exacerbate the blanket of greenhouse gases warming the world as well as chew up the stratospheric ozone layer protecting the planet's inhabitants from excess doses of ultraviolet sunlight.

Such refrigerants can be turned to cash, either the old-fashioned way—making and selling them—or by destroying them to reap carbon credits. In 2005, destroying such refrigerants "was the big thing," said Lenny Hochschild, a broker at Evolution Markets. "It was the low-hanging fruit, but that's all gone now."

That's why Waziri "Waz" Garuba, who came from Goldman Sachs and Columbia University's MBA program to become the newest member of the Evolution Markets carbon team at the end April, laboriously tweaks data in a financial model he is building in Microsoft Excel. Under what circumstances does destroying refrigerant gases still makes economic sense, factoring in all relevant costs and fees, such as the 3.5 percent commission Evolution charges on every deal? "Is this profitable?" Waz asks and tries to answer for trichlorofluoromethane, dichlorodifluoromethane and other refrigerant gases.

It's definitely not about tree-hugging for anybody on the Evolution carbon team. "I'm not that in love with polar bears, and I don't think they'd like me too much either," Waz said, phone hanging over his shoulder as he types another instant message. "Being born in Nigeria, I understand the value of the environment.... You can protect the environment by putting value on it."

For example, landfills leak methane gas as microbes degrade the trash within. Harvesting that landfill methane for use as a fuel also offers greenhouse gas reductions, since methane traps 23 times as much heat in the atmosphere as CO2 over a century. So Evolution advises landfill operators on what price they might get for, say, 100,000 metric tons of avoided emissions over a 10-year period. "Six-fifty," said broker David Nussbaum, meaning $6.50 per metric ton per year, "maybe less." Hochschild disagreed. "We'd be lucky to get you five," partially because the U.S. Environmental Protection Agency may further clamp down on such fugitive emissions, reducing their value as offsets. In fact, the EPA is currently considering whether to mandate the elimination of HFC-134a.

And that is the most devilish detail of all: So-called "additionality," the concept that in order to count against some kind of national or international budget for greenhouse gas emissions, the emissions avoided or reduced must be in addition to what would have happened anyway. So, for example, a new wind farm is "additional" if the money from the CO2 emissions saved helps enable it to get built in the first place. If it would have been built anyway, then it doesn't really save emissions. This has led some critics, such as NASA climatologist James Hansen, to dismiss offsets as a con game. "There are a huge number of industries and people who do not want us to move to the world beyond fossil fuels - these are the biggest fans of cap-and-trade," he wrote in a May 2009 letter to carbon traders. "Next are those who want the process mystified so they can make millions trading, speculating, and gaming the system at public expense."

Standing guard over the additionality concept and generally vouching for the credibility of any given project—the key to any shred of environmental credibility as far as reducing greenhouse gas emissions goes—are standard-setters like the Climate Action Reserve from California or the Voluntary Carbon Standard from Washington, D.C. Then there are the verifiers, consultants like Det Norske Veritas (big in shipping inspection) or SGS (which got its start weighing grain shipments), who ensure that projects actually reduce emissions.

Unfortunately, the verifiers don't always verify: the United Nations has suspended both DNV and SGS for periods of three months in the past few years after verifiers of the verifiers found that they didn't have the technical skills to appropriately assess various projects. Nor is the problem confined to the private sector; the government of Hungary explicitly sold carbon credits to Japan that had already been used to offset domestic emissions—in effect, double counting the same theoretical emission reductions. Partially as a result, the U.S. Government Accountability Office disparaged offsets in a recent report, calling into question not only their efficacy but also their cheapness (their primary selling point).

After all, greenhouse gas emissions continue to rise—concentrations in the atmosphere creep up by roughly 2 parts-per-million per year. And an analysis published in Proceedings of the National Academy of Sciences suggests that any decline in emissions in Europe has simply been outsourced to China. Firms that make HFC-23 have been overstating their emissions, according to non-governmental watchdog group CDM Watch, in order to qualify for even more money for bogus emission reductions. Some experts argue that countries are doing the same thing, allowing destructive practices to go forward now in order to set a high level of emissions that it will be easy to profit from. An analysis by David Victor at Stanford University estimates that as much as two-thirds of the emission reductions registered under the CDM were so-called "fake tons," or not reductions at all.

In this market, brokers do not have to worry about the regulations of the Securities and Exchange Commission, or the commodity and futures oversight boards. Outright fraud has plagued emissions markets, whether it's Anne Sholtz building a Ponzi scheme out of smog allowances in Los Angeles or European cheats charging extra for carbon allowances under the guise of collecting a tax and then disappearing with the proceeds. So far only voluntary commitments and a code of ethics drawn up by the Energy Brokers Association keep players honest—though the new financial reform regulations may change that.

"It's not a bunch of Wall Street traders putting together a con game," Hochschild countered. "This is real companies making real reductions. If there is an appropriate price point, people are going to be incented to produce carbon offsets, which will reduce carbon emissions." Hochschild thinks that "appropriate price" is roughly $20 to $30 per metric ton of carbon dioxide - or roughly twice what carbon dioxide trades for in the European market. "It needs to be high enough to effect change and not affect the economy," Hochschild said. "Is an 8 percent increase in electricity bills worth getting off foreign oil, solving global warming adding jobs and creating a new economy? I would argue that's a no-brainer."

"This is the most efficient way of resolving climate change, not just a tax and not just technology because there's no guarantee emissions go down," Hochschild continued. "It should happen in the next couple of years." Of course, that's what people have been saying since at least 1992.

"There is an interesting story to be told looking back through the 20th century at the drivers of wealth creation," wrote Richard Sandor, founder of the Chicago Climate Exchange, a voluntary trading regime for carbon dioxide, in the October issue of Environmental Finance, the trade magazine of emissions markets. "In the 1990s, it was the commoditization of information. Looking forward, I think the 21st century will be driven by the commoditization of the two most important resources on the planet: Air and water." Nevertheless, Sandor cashed out of at least the air commodity business this spring, selling CCX to IntercontinentalExchange for $600 million.

Some economists believe a simple tax on greenhouse gas emissions makes more sense than the elaborate cap-and-trade regime for carbon dioxide envisioned by Evolution and other players in the nascent market. After all, a global market would be hard to police, and even in the United States authority might be spread among several agencies, from the EPA to the SEC. And the EPA is moving forward with regulations that may simply mandate a cut in greenhouse gas emissions. "There's a fair chance that if EPA moves forward, it will be command and control," said Josh Margolis, CEO of environmental brokerage CantorCO2e. "I got into this business in the mid-1980s and there was no cap-and-trade program; it was a program that focused on people who could create reductions and needed them to expand or build new facilities."

But trading allows the market to work its efficient magic on the reduction of air pollution, from Hochschild's and Evolution's perspectives—and that remains the national negotiating position of the United States: Companies that can make reductions do so because they have a financial incentive. Companies that cannot afford to do so can buy compliance for a reasonable price. In their minds, a deal is good for their finances and the environment.

As the old Evolution slogan went: "Saving the planet, one trade at a time."

This article originally appeared at The Daily Climate, the climate change news source published by Environmental Health Sciences, a nonprofit media company.